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Self-employed workers can incur major tax debts

On Behalf of | Apr 30, 2023 | Tax Law

Most people are direct-hire employees and have been classified as such ever since their first teenage jobs. They fill out a W-2 with their employer, receive their paycheck and then file a tax return each year in April to get a refund. The system works well for the average employee because they never have to think about taxes.

However, the payroll withholding system used for income taxes can put those who transition to certain new jobs at a disadvantage when it comes to tax compliance. Those who switch from a job where they are an employee to a profession as an independent contractor may learn too late that they have failed to retain the resources necessary to meet their tax obligations. These are the two primary oversights that new independent contractors often make concerning their income taxes.

They fail to make quarterly payments

Estimated quarterly tax payments are a way to keep those tax obligations from snowballing into an insurmountable amount at the end of the financial year. Sending an estimated quarterly payment is a requirement every year after the first year that someone files their tax return as an independent contractor.

The first estimated payment of the year is due on the same day that income tax returns are due for the prior year. People who fail to make those quarterly payments may have penalties assessed that they have to cover. They may also find themselves with a very large tax bill, possibly tens of thousands of dollars.

They don’t retain funds to pay their taxes

Those who have grown acclimated to employer withholding systems and an annual tax refund may build a budget where they spend every dollar that they earn from each paycheck.

Then, when the time comes to file their annual tax return, they come to the very uncomfortable realization that they do not have the money on hand to pay their income taxes for the year. If they do have some money set aside, it may fall far short of what they have to pay, independent contractors cover more in their self-employment taxes than employed workers pay from each paycheck.

There are options for negotiating payment plans available for those who have already fallen behind, as well as guidance and support available for those who are about to transition from an employee to an independent contractor status and need to protect themselves. Getting help when the tax laws that apply to someone change can reduce the risk of a tax controversy or audit.